High-speed rate hikes may be on the horizon

After remaining unchanged at about $40 a month for the past few years, high-speed Net access could get more expensive, according to industry analysts and executives.

5 min read
The price of high-speed Internet access could be headed higher.

After rates have remained unchanged at about $40 a month for the past few years, industry analysts and executives say a confluence of several events may mean rate increases are on the way.

Among the warning signs:

 Many DSL (digital subscriber line) companies are seeking buyers or are in bankruptcy court--including Flashcom, PSINet and others--or are financially weakened, such as Covad Communications. Less competition opens the door for survivors to bump up rates because consumers have fewer alternatives.

 A plunge in advertising revenue is forcing providers to find other sources of revenue.

 Demand remains high for broadband services.

 Consumers have grown accustomed to regular increases in rates for utilities such as cable TV, natural gas and electricity. This may embolden broadband companies to up their own rates.

 The largest ISP, AOL Time Warner, is considering increasing its monthly dial-up fee of $21.95, which could spill over to other dial-up providers and broadband companies.

Gartner analyst John Girard looks at why competition in the DSL market will diminish--causing prices to rise--and what other effects the lack of competition will have.

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"Raising prices is a natural reaction. I think it's to be expected," said Jeff Sadler, an ISP stock analyst at FAC/Equities. "If you're not making money on advertising and you've got objectives to meet, raising prices is one of the ways to do it. Who is going to step in to counter it?"

Charles Ardai, chief executive at Juno Online Services, echoes that sentiment. "The cost of rolling out the (broadband) network is too high relative to the revenue it produces. If the revenue is not meeting their costs, I do think you'll see a trend toward higher prices," he said.

Juno provides primarily free dial-up access, but also offers broadband access through several partners for $49.95.

One major broadband provider already bumped up its rates, and there is speculation that even dial-up Internet leader America Online will raise its rates this year.

Earlier this month SBC Communications, a major Baby Bell local phone company and the nation's largest provider of DSL, ended a yearlong promotion that caused its high-speed Internet service for consumers to climb to $49.95 per month from $39.95. Consumers no longer are required to sign a one-year commitment, however.

In addition, SBC instituted three new offers for consumers who would like to purchase a personal computer at discounted prices in conjunction with their DSL order. SBC believes the company's new, higher DSL rates are more desirable for consumers because customers no longer must sign a long-term service commitment.

"We feel that $49.95 is a competitive price point. We wouldn't have ended our old promotion and replaced it with this new one if we didn't think that we'd continue to see strong demand," said SBC Communications spokesman Fletcher Cook. "We're just as excited about this promotion as we were about the last one. We're adding additional flexibility and convenience for consumers."

Meanwhile, AOL executives are calculating the additional revenue the company could collect from its 27 million subscribers with a modest bump in rates. One reason: It needs to boost revenue to justify its megamerger with Time Warner.

The company's top executives have said they are considering price hikes, and now some analysts believe a dial-up rate hike is likely.

"We are becoming skeptical that AOL Time Warner can fully reach its goal of $11 billion EBITDA (earnings before interest, taxes, depreciation and amortization) in 2001 without a price increase at AOL," ABN AMRO equity analyst Arthur Newman wrote in a recent research report. "If a price increase of $2 per subscriber were to be instituted around midyear, and all the Time Warner sectors perform at optimistic levels, the $11 billion could be reached, but it might be a stretch."

The economics of broadband
As AOL considers a price hike, analysts point out that its dial-up service is cheaper to maintain--additional evidence that price pressure could spill over to the broadband sector, where the cost of delivering service is higher.

The equipment necessary to install a broadband connection is expensive, meaning providers generate roughly the same amount of profit margin from a high-speed customer as dial-up ISPs collect for their $20-a-month services.

"The profit margin for a DSL customer is about the same dollar contribution as from a dial-up customer," Sadler said. "But on a percentage basis it's a smaller profit margin."

In other words, the capital investment costs of provisioning service for a broadband customer are higher, but the actual profit is roughly the same as offering dial-up Net access, analysts say.

Sadler estimates that on a $40 broadband connection, roughly $25 to $28 dollars goes toward equipment costs, overhead and leased-line charges to the Bells, and after other administrative costs leaves roughly $8 to $10 in profit--before marketing costs such as advertisements or direct mailers.

"It costs almost $900 to provision a single DSL customer," said Emily Meehan, a senior Internet industry analyst at The Yankee Group, a market research firm. "It's very expensive...We've told DSL providers, 'Don't rush into dropping your prices, because you'll run into a business model snafu once the demand comes.'"

Juno's Ardai concurs, noting that "the cost of using a dial-up network has dropped over the past four or five years but the same cannot be said for broadband."

"The up-front costs of setting up a customer potentially can swamp many months or years of profits," Ardai said. "This is one of the fundamental problems with broadband today."

What next?
Not everyone is convinced, however, that consumers who enjoy high-speed downloading and Web surfing need worry about imminent increases.

Gray Hancock, a senior analyst for communications infrastructure at Current Analysis, a market analysis firm, argues that DSL line-sharing laws, which allow competitors to carry traffic over consumers' existing phone wires without incurring the cost of leasing a second phone line, will lead to lower-cost broadband connections. Hancock also believes there is enough competition yet to ensure further pricing battles.

"I think prices are likely to fall," Hancock said. "If they lower their price, they're likely to get more people. The lower you make the price point, the more subscribers you'll get."

Nevertheless, others say price hikes, such as SBC's recent DSL rate increase, are practically inevitable.

"To see somebody respond in a manner that tries to get profit margins going is entirely reasonable," FAC's Sadler said.

The increases also may not be so easy to detect. Major communications carriers such as AT&T have for years vowed to offer consumers a bundled package of services, such as local and long-distance voice, wireless communications, high-speed Internet access and digital television services.

"They're going to have to find an innovative way to bundle a lot of the cost into a larger package," Meehan said. "Overall the cost will go up but it won't just be pure connection; they'll offer something else with that."

Even if prices are to rise, analysts say consumers will come to tolerate small rate hikes rather than endure the hassles of switching providers, e-mail addresses and other tangles associated with adopting an alternative provider.

"Incremental increases are acceptable. Large ones must be accompanied by some additional value," Meehan said. "The market will bear it because as consumers become increasingly reliant on the Web they'll have no choice but to accept it. It'll be very gradual increases."